Amcom mid year results (AMM)

This week Amcom announced their half year results to the market. Key points:

Revenue up from 29m to 41m 43%
NPAT up from 7.6m to 9.9m 30%
Final dividend increased from 0.4c to 0.6c up 50%

Much of these results are flowing on from the EOFY10 results Amcom posted in which earnings increased by 42%. It is also worth noting that while the business is growing, EPS was flat at 1.4c. Importantly, this is our first look at the results of the IP Systems acquisition and the performance of the NT Government contract.

Firstly on the IP Systems acquisition, this new subsidiary is already showing benefits from integration, with revenue from this business unit increasing 30% by cross-selling existing data clients. For now at least, my skepticism appears to be misplaced, as the rapid uptake of IP Systems services should be an important source of growth when Amcom’s data business begins to mature.

The NT Government data network has already been rolled out, and since signing the original contract, Amcom have written 500k worth of new orders. Nextgen’s competitive backhaul to Darwin should be complete by September this year, helping Amcom reduce their wholesale network costs to Telstra. As discussed in my previous post, Amcom has bucketloads of opportunity in Darwin due to the lack of competition in this market.

It’s obviously still early days for the partnership with Bluefire, but there is significant potential for Amcom to write Cloud business with existing customers, due to the variety of cloud offerings and the SaaS nature of the Bluefire solution.

One negative is the performance of the Amnet consumer DSL business, which is being squeezed with both revenue and EBITDA decreasing. It would make sense for Amcom to offload this business to iiNET and focus on their Enterprise/Government clients instead.

The half year report came with an upgraded earnings guidance estimating Amcom’s year-end NPAT at 21.6m, however there are opportunities for further upside this FY in growth of the NT business, increased services through IP Systems, and the uptake of cloud services with Bluefire. The dividend increase demonstrates confidence in future earnings. With a PE ratio of 10.5 and plenty of room for continued growth, I currently have no plans to exit my position in AMM.

Supply Network (SNL)

Market Cap: 17M
P/E: 9.2
P/B: 1.31
Dividend Yield: 6%

With a market cap of only $17M and thin trading volumes, a sensible investor would shy away from a company like Supply Network, which supplies truck and bus parts. Fortunately these disadvantages are minor enough not to be insurmountable, and Supply Network’s niche operations generate a decent cashflow.

SNL’s dividend history goes back to 2001 and at 7.9 x earnings is selling for an attractive price. Dividends are high and can be re-invested at a 5% discount.

What you do get when you buy SNL, is a steady business selling for not much more than book value, which continues to produce steady earnings. The 4 company directors are all subscribed to the Dividend Reinvestment Plan, collectively owning 17.6% of the company.

Supply Network are currently in year 2 of a 3 year growth strategy, aimed to grow organically by increasing network capacity and customer service. FY10 saw modest profit and revenue growth around 7%, which is net of a recent investment in new staff, branch expansion, and IT systems. The unaudited half year FY11 report showed a 40% increase to NPAT pcp which will be largely offset by an increase to 2nd half costs associated with new systems and the opening of the Mackay branch. Regardless, full year EBITDA has been revised upward from 3M to 3.1-3.3M.

Long-term, I see Supply Network as a business which will grow roughly in line with the economy, with potential for a bigger profit jump short-term by improving current business processes. While it lacks the prospect for spectacular earnings growth, this steady business has survived the GFC with no material impact and focusing on their core market means a more certain future.

Given the limited prospects for high growth, I plan to sell my holdings in SNL should it ever reach 15x earnings. If not, I anticipate continuing to hold this business for years to come.

Amcom (AMM)

Market Cap: $229m
P/E: 10.9
P/B: 1.55
Dividend Yield: 4.5%

This gunslinger of the wild west has had an interesting history. Founded in Perth in 1988 as a cabling contractor, Amcom gained a carrier license in 1998. In 1999, it was acquired by a gold exploration company called International Minerals, who divested their gold project and changed their name to Fibretel.

Today Amcom’s network connects over 1200 commercial buildings in Perth, Adelaide, and Darwin. While the core business is focused on providing fibre-based data services to Enterprise, Government and Wholesale clients, Amcom also operates a 20,000 connection DSL network which contributed $2.6M to EBITDA in FY10. Amcom also owns 23% of $400m consumer ISP iinet (IIN) which provides roughly a million services across Australia and has achieved an average annual shareholder return of 16.7% for the past decade. A serial acquirer of its competitors, iinet is positioned to lead the consumer DSL market through its size and leading customer experience, although their main competitive threat, TPG, is a very aggressive player. IIN contributed $7.8m to AMM’s earnings in FY10.

Amcom’s biggest win of FY10 was a 5 year, 20M contract with the Northern Territory Government to provide data services. The Northern Territory is one of the least competitive areas of Australia in terms of telecommunications, particular in “on-net” infrastructure which doesn’t rely on Telstra’s copper network. I expect to see a significant increase in Amcom’s business in the NT, both organically to NT Government and to the NT business market. There should also be potential to wholesale to other carriers operating national data networks but lacking significant access infrastructure in NT.

In FY10 Amcom also acquired boutique VOIP operator IP Systems, to complement their data network reach with IP voice connectivity and a national network footprint. I am waiting to see how well this pans out, as enterprise IP voice is a technically complex service more suited to the domain of traditional voice carriers. While there is potential to cross-sell to each other’s clients, in the long term (past 2020) I think most enterprises will be operating entirely on mobiles, apart from the contact centre. In the future this market will be controlled by specialist contact centre practices who can provide a slew of value added services. The acquisition could provide potential benefit if Amcom can use IP Systems’ POPs on the eastern seaboard to begin bidding for national data networks and delivering new services to their existing clients.

Today Amcom announced their partnership with Bluefire to provide cloud computing services over their fibre infrastructure. This is much more exciting than the IP Systems acquisition as despite all the hype, I see a big future for cloud computing. While many providers use the internet to deliver services (all you need is a few racks in a data centre, some servers, and a virtualisation environment like Vmware), carriers with access infrastructure can deliver services over private network, giving better service quality for real-time enterprise applications.

Over the course of the last financial year, AMM’s share price doubled from 16c to 32c, thanks to IIN’s share price appreciation and a significant increase to both earnings and dividend. Since then shares have been trading in the 30c-35c range which equates to 10-13 x earnings. This Financial Year Amcom expect to increase NPAT by at least another 20%, but I wouldn’t be surprised to see this jump even higher.

The beauty of the telecommunications business is the fixed cost base and small marginal cost of adding new services. Once you have enough customers to pay for this fixed cost base, new services usually just fatten your margins (unless significant capital works are required through investment in new infrastructure build). If you are a carrier, your future is a lot more certain when you’re in the access infrastructure game, because the barriers to entry are a lot higher than if you rely on other carriers access networks (or if you are a straight reseller). Although telecommunications is a deflationary business (think about how much you paid for a mobile phone call 5 years ago), this is offset by increased demand for data. Amcom’s network is in a much less competitive area, reducing this deflationary pressure which is much higher for data on the East cost of Australia, and much higher for fixed voice.

This means once you have enough services to pay the bills, your network becomes a cash cow, generating free cash (AMM generated 21M in FY10) which you can either return to the shareholders, expand your network footprint to target new markets, or use to make acquisitions to broaden your service offerings.

Back to margins, these are something AMM has in spades, one of this company’s biggest advantages. Amcom’s NPAT margin in FY10 was 16.7%, based on revenues of $63.1m and NPAT of $10.6m. I wouldn’t be surprised to see this decline slightly in the next reporting period due to the IP Systems integration, but provided the inclusion is successful, I anticipate AMM’s profit margins will continue to grow.

The threat of the NBN is not significant in Amcom’s case, due to their targeting of the business market and their typical network speeds in the 100Mbit – 10Gbit range.

I have been holding AMM since 2009 and intend to continue to do so for the foreseeable future. With a 4.6% dividend yield, lack of serious competition, and significant opportunities for earnings growth outlined above, I don’t plan to sell my holdings unless the company’s price began to approach 20 x earnings. Based on their current PE multiple of 11, AMM’s share price would have to double.

AMM is a potential takeover target of TPG Telecom (TPM), which has acquired Soul and Pipe Networks. Amcom’s fibre network would complement the strong east coast presence of Pipe’s fibre network. The takeover could be partially funded by divesting Amcom’s $95m holding in iinet.